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Central Bank Interest Rates and Recession Fears Push Stock Markets Lower


3 October 2022

US stocks dropped more than 2% in August marking the biggest fall in 2 months and reflecting concerns about a potential recession and further interest rate hikes. Technology shares fell as the economic outlook appears pessimistic while economists fear that Federal Reserve members will remain hawkish and support further large rate hikes.

Gloomy economic news

Economic news was gloomy, as data showed that economic activity in China slowed down due to new Covid infections, property sector issues and the worst heatwaves in decades. Investors avoided Chinese stocks as data showed the world’s second-largest economy slowed in the second quarter, with only a 4% increase from the previous year. Asian equities weakened due to shrinking factory activity in the Chinese economy.

The Shanghai stock exchange also dropped after news of a lockdown in the Chinese city of Chengdu where 16 million people live. This is an attempt to contain a Covid-19 outbreak which will likely deliver another blow to an already faltering economy.

Headline Eurozone inflation for August continued to rise which strengthened expectations for a large rate hike by the European Central Bank in its next meeting. Concerns about cutting of gas supplies added to fears of energy rationing in some of Europe’s biggest economies this coming winter. The energy crisis has exacerbated the cost-of-living crisis for consumers and businesses who continue their calls for further support from governments. German bonds underperformed as Eurozone inflation reached new highs.

Which stocks have declined?

Wall Street’s S&P 500 index slid while there were declines across every sector, with tech stocks and consumer groups such as Amazon and Tesla being among the biggest losers. The Nasdaq Composite index also fell. Tech stocks that promise long-term growth are particularly susceptible to rising interest rates because higher rates diminish the relative value of earnings in the future.UK’s FTSE 100 index fell sharply at the end of August as mining stocks pushed the commodity-heavy index lower.

Worries of further interest rate hikes by central banks and their effect on consumer demand, along with weak data from Asia added to the gloomy global economic outlook.

Interest rate hikes in major economies

While there are higher interest rate expectations in the US, in the UK, the Bank of England would be forced to slow down rate hikes due to the cost-of-living squeeze. The European Central Bank will soon announce an interest rate decision. It raised borrowing costs earlier in the summer for the first time in more than a decade by a double rate hike of 0.5 percentage points to zero. Morgan Stanley and other Wall Street institutions expect a bigger 0.75 percentage point rate rise at the ECB’s September meeting.

Morgan Stanley said: “We think it is a very close call, with good arguments on each side, but ultimately think those advocating for a larger hike will prevail as September offers the best opportunity to send a clear signal of determination.”

Fed interest rate hikes drive stocks lower

The Nasdaq is at the centre of interest rate uncertainty in the stock market and with the Fed being hawkish and ready to deliver further interest rate hikes, it is reasonable that the market feels nervous, analysts have noted. The Fed has raised interest rates three times this year in an attempt to manage surging inflation and bring it down from its 40-year highs. Fed officials have noted that the US central bank has more way to go yet and more rates should be expected. Analysts fear that the stock market will face more downside risks, and that even if the stock market rises, this will be a temporary relief rally.

Fed chair Jay Powell has already stated clearly his intention to continue with aggressive rate hikes.  In a speech at Jackson Hole central banking conference in Wyoming, Powell said the Fed will raise rates and would keep them high for some time to curb inflationary pressures.  As he said, the central bank would “keep at it until the job is done” on inflation.

New York Fed president John Williams said in an interview with The Wall Street Journal on Tuesday that the central bank will need to hold interest rates high throughout 2023 to control high inflation.

Will stocks fall further?

Investors are wondering whether stocks will fall as low as they did in June. September is historically a poor month for markets. Following the recent hawkish comments from Fed officials who are determined that the Fed proceeds with further interest rate hikes, the stock market could be at risk. Analysts have noted though, that stocks may fall further if there are negative economic data such as earnings revisions that come out worse than investors are expecting.

Already, September is looking gloomy, with global stock markets being downbeat on weak Chinese data and new Covid-19 lockdowns. While rising inflation was responsible for declines in the first half of the year, analysts have warned that the next losses will be connected to falling corporate profit margins.

As the Financial Times reported, expectations of tighter monetary policy and a prolonged recession has already created concerns about the financial health of businesses.

Worrying global outlook

Markets remain unable to recover from recent declines and investors expect tougher times ahead. Fears of recession and a troubled China will remain key issues. As economists noted, with the world’s two largest economies under pressure, the current outlook is weak and disappointing.

For those trading stocks online via online CFD stock brokers, keeping a close eye on the latest announcements of central banks, and news on interest rates, as well as news from Asia and the Eurozone, will provide a clearer view of how markets will respond. Inflation, recession fears, the energy crisis and the cost-of-living crisis, as well as Covid-19 lockdowns will continue to rock the stock markets and more broadly the financial markets.

To keep your finger on the pulse of the latest market news, ensure you visit the IronFX School and to read the latest financial news articles. The IronFX Blog will also offer a rich range of market articles and analyses on your favourite trading instruments.

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